Not sure if you ever got it work with the steering wheels controls. But with mine (2011 E90 not sure if it makes a difference) I deleted all my songs like you. This fixed the switching to the music app. Now I plug in my phone when the song is paused. Then select ipod on the headunit. It starts immediately and I can use the steering wheel controls. You also have to select the random button on the headunit for the steering wheel controls to work for some reason.

In my 2007, the Head unit only shows CDC, which is what controls the ipod, it doesn't actually say ipod, so it seems this is something BMW fixed with the newer cars. so i think its safe to say that steering wheel controls will only work with LCI cars and this dealer ipod option?